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3 Ways to Put Your Next Raise to Work

Even as the economy continues to recover in this post-financial crisis era, it’s no secret that one of the issues hindering the recovery is the lack of real wage growth. Many people are earning the same amount they were 10 years ago while inflation, though still relatively low overall, has caused the price of goods to increase. Additionally, the cost of certain big-budget items, such as education and healthcare, have dramatically outpaced inflation and wage growth.

All this means that the same amount of money can feel like a lot less these days but, at the same time, most people feel fortunate just to have jobs. However, if you are lucky enough to hold a position that has given you consistent raises or you expect to see a decent raise in the near future if the economy continues to recover, don’t let those increases in pay simply trickle into your budget and raise your standard of living. Be deliberate about how you allocate the extra money in your paycheck to make sure that it goes straight to your net worth’s bottom line. Here are a few ideas on how to do just that.

Pay down debt. Paying down debt is a great use of extra funds because it is a guaranteed return on your money and one that you don’t have to pay taxes on. Putting cash in an investment that earns 8 percent really amounts to a ~6 percent return after you factor in taxes. However, paying down credit card debt or a car loan that is at 8 percent means you get an 8 percent real return.

Start by putting your extra cash towards paying down your debt with the highest interest rate but even if your only debt is a low interest, tax-deductible mortgage, paying a little extra may not be a bad idea. Consider this: if you have a 30-year $350,000 mortgage at 4.5 percent, paying just an extra $1,000 per year will cut 2.5 years off your loan!

Increase your retirement contributions. If your employer offers a 401(k) or other retirement plan option, one great thing about it is that the money you contribute comes out of your paycheck automatically. Since it’s hard to spend money you never see, stashing your raise away for retirement is a great way to make sure it goes to work for you. If you get a 3 percent raise, bump up your retirement savings by the same amount and let the magic of compounding interest help fund your golden years. Another nice benefit? If your 401(k) is a traditional account (rather than a Roth), you won’t even feel the full 3 percent hit your paycheck because it is a pre-tax deduction.

Fund college accounts. If you are planning on helping your kids pay for college and have been slacking a bit on savings, using your raise to pad these accounts can be a great idea. If you haven’t already opened a 529 plan, now is the time to do it, especially if your state offers a deduction benefit. For example, New York State allows a married couple to deduct up to $10,000. Assuming you make $150,000 annually and get a raise of $5,000 that you use to fund a 529, you’ll save $300-$400 on your taxes. Do this year after year and the savings really start to add up on something you would have been paying for out-of-pocket anyway.